What is IPO: Meaning, Types, Working, Eligibility & Benefits

If you are interested in financial investments, you must have often encountered the term ‘IPO’. But have you ever wondered why this term is a buzzword in the investment landscape? Well, Initial Public Offerings, popularly known as IPOs, are crucial for any company heading for a listing on the stock exchange. Launching an IPO is a significant step for any business as it allows them to raise capital from investors.

This article simplifies the concept of an IPO and walks you through its meaning, types, functions, eligibility, pros and cons, and what you need to remember before investing.

• Table of contents

1. What is an IPO?
2. Types of IPO
3. How an initial public offering (IPO) works
4. What is the IPO timeline?
5. Pros and cons of investing in IPO
6. Cons of investing in an IPO
7. What are the eligibility criteria for an IPO?
8. Why does a company offer an IPO?
9. How to invest in an IPO?
10. Things to remember while investing in an IPO

What is an IPO?

An IPO, or Initial Public Offering, is when a company offers its shares to the public for the first time. This process marks the company's transition from being privately owned to becoming publicly traded on a stock exchange.

By going public, the company can raise money from investors to fund to its growth, expand operations or pay off debts. At the same time, an IPO gives investors the chance to buy shares and become shareholders of the company. For a business, an IPO is a major milestone that increases its visibility, credibility, and access to a larger pool of investment funds.

Types of IPO

Fixed price offering:

• The company sets a fixed price for its shares.
• Investors know the share price beforehand.
• To invest, they must pay the full price of the shares while applying.

Book building offering:

• The company provides a price range, called the price band (e.g., a minimum and maximum price).
• Investors place bids, deciding how many shares they want and the price they are willing to pay.
• The lowest price in the range is the floor price, and the highest is the cap price.
• The final share price is decided based on these bids.

How an initial public offering (IPO) works

• Choosing an underwriter or investment bank: The company hires financial experts to assess its financial health, manage the IPO process, and connect with potential investors.
• Preparing IPO documents: The company prepares a detailed registration statement and a Draft Red Herring Prospectus (DRHP) as per SEBI guidelines. These documents explain its operations, finances, and plans to investors.
• SEBI approval: SEBI reviews these documents to ensure they are accurate and transparent. Once approved, the company can proceed.
• Listing on stock exchanges: The company applies to stock exchanges to list its shares for public trading.
• Marketing the IPO: Efforts like ads, social media and roadshows attract investors.
• Setting the price: The company chooses a fixed price or book building method for pricing shares.
• Bidding and allotment: Investors place bids, and shares are allocated based on availability.

Read Also: How to Invest in Initial Public Offering (IPO)?

What is the IPO timeline?

• Preliminary stage: The company plans and prepares necessary documents for submission to regulators.
• Approval stage: The regulatory authority reviews and approves the prospectus.
• Subscription period: Investors can apply for shares within a specified timeframe, usually 3-10 days.
• Allotment and listing: Shares are allocated to investor and the company’s stock is listed on the exchange.

Pros and cons of investing in IPO

Pros of investing in an IPO

• Early investment opportunity: IPOs allow investors to buy shares at an initial price, which can potentially rise after listing.
• Growth potential: Investing in a growing company has the potential to yield significant returns over time.
• Transparency: The company’s financial details are disclosed in the prospectus, helping investors make informed decisions.
• Diversification: IPOs provide an opportunity to diversify your investment portfolio.

Cons of investing in an IPO

• Market volatility: Newly listed stocks can experience high volatility, leading to unpredictable price movements.
• Limited information: Despite the prospectus, there may be limited historical data to analyse.
• Risk of overvaluation: In some cases, IPO shares may be overpriced, leading to potential setbacks.

What are the eligibility criteria for an IPO?

Initial Public Offerings (IPOs) in India are regulated by the Securities and Exchange Board of India (SEBI), which sets specific eligibility conditions. These are put in place for investor protection and to ensure orderly market conduct.

These conditions mainly assess the company’s financial performance, business history, and regulatory compliance.

Key requirements for companies planning an IPO include:

Financial performance:

• The company is generally expected to have net tangible assets of ₹3 crore or more in each of the past three full financial years.
• It should have earned an average pre-tax operating profit of at least ₹15 crore in any three of the last five years, with positive operating profit in each of those three years.
• The company should also have a net worth of at least ₹1 crore for each of the preceding three full financial years.

Business history:

• A continuous operational track record of at least three years is usually expected, either by the company itself, its promoters, or a converted partnership firm.

Regulatory compliance and governance:

• The company should not be under review by the Board for Industrial and Financial Reconstruction (BIFR), and there should be no accepted winding-up petitions with the National Company Law Tribunal (NCLT).
• Promoters and directors must meet prescribed integrity standards and should not be classified as willful defaulters or fugitive economic offenders.

Companies that do not meet the profitability benchmarks may still become eligible to list if they reserve at least 75% of their public issue for Qualified Institutional Buyers (QIBs).

Why does a company offer an IPO?

• Raising capital: IPOs help companies generate funds for expansion, research, and other growth activities.
• Debt reduction: The proceeds from an IPO can be used to repay existing debts.
• Enhanced credibility: Publicly listed companies often gain better recognition and credibility.
• Liquidity for shareholders: Existing shareholders can sell their stakes in the company during or after the IPO.

How to invest in an IPO?

• Open a demat account: A demat and trading account is essential to apply for and hold shares.
• Check for IPO Announcements: Keep an eye on upcoming IPOs through stock exchange websites or brokerage platforms.
• Apply for IPO: Use your broker’s platform or bank’s ASBA (Application Supported by Blocked Amount) service to apply.
• Wait for allotment: After the subscription period, shares are allotted based on demand.
• Start trading: Once listed, you can trade the shares on the stock exchange.

Read Also: What is the difference between NFO and IPO?

Things to remember while investing in an IPO

• Conduct thorough research: Take time to understand the company’s business model, financial health, industry position and growth potential. Strong fundamentals are a good indicator of a promising investment.
• Read the prospectus carefully: The IPO prospectus is a detailed document that provides valuable insights about the company’s operations, financials, objectives and risks. Reading it will help you make an informed decision.
• Understand the risks: Every investment carries risks. Assess market conditions, industry trends and factors that could impact the company’s future performance before committing your money.
• Avoid oversubscription hype: High demand for shares doesn't always mean high returns. Stay objective and don’t invest solely based on market buzz.
• Have patience: IPO investments often yield better return potential over the long term. Avoid expecting instant profits and focus on the company's long-term growth potential.

Conclusion

An Initial Public Offering (IPO) can benefit both investors and companies. For investors, it’s a way to be part of a company’s growth journey. For companies, it’s an opportunity to raise funds and reach new goals. However, IPOs also carry risks, just like any other investment. By staying well-informed and making thoughtful decisions, you can maximise the potential of investing in IPOs.

FAQs

What is the full form of IPO?

IPO full form is Initial Public Offering.

Is IPO profitable?

While IPOs can be profitable, they also carry risks. Profitability depends on the company’s performance and market conditions.

How to sell IPO shares?

Once listed on the stock exchange, IPO shares can be sold through your trading account from the stock exchange.

Is IPO a stock or a share?

An IPO represents shares of a company being offered to the public for the first time.

How is an IPO priced?

IPO pricing is determined either through a fixed price method or a book-building process based on demand and supply.

How is IPO profit calculated?

IPO profit, often referred to as a listing gain, is calculated by subtracting the issue price (the price at which shares are allotted) from the listing price (the price at which the shares begin trading), then multiplying the result by the number of shares allotted. For example, if you are allotted shares at ₹100 and they list at ₹120, your gain would be ₹20 per share.

What is an IPO in simple terms?

An Initial Public Offering (IPO) is when a private company offers its shares to the public for the first time. This allows the company to raise capital for business expansion. The investors get a chance to become shareholders and potentially benefit from the company’s future performance.

Is it good to buy in an IPO?

Investing in an IPO can be beneficial as it provides early access to a company’s shares. One of the benefits of IPO is the potential for long-term growth. However, IPOs can experience sharp price movements.

Who can invest in IPOs?

In India, IPOs are open to several investor categories, including resident retail investors, non-institutional investors, and qualified institutional buyers (QIBs). To apply, an individual generally needs a PAN card, a Demat account, and a bank account linked to UPI for payment.

What is an IPO in the stock market?

In the stock market, an IPO represents the process through which a private company becomes publicly listed by offering its shares to investors for the first time.

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